Cambridge (CIE) IGCSE Your notes

Accounting
The Purpose of Accounting
Contents
Book-keeping & Accounting
Profit or Loss & Financial Position
The Accounting Equation

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 Book-keeping & Accounting
Your notes
Book-keeping
What is book-keeping?
Book-keeping is the process of keeping detailed records of financial transactions
Book-keeping is done by book-keepers
They record the day-to-day transactions of the business
The information is obtained from business documents
Such as bank statements, receipts, invoices, cheques, etc
The book-keeper makes the records using a system called double entry book-
keeping
Every business, no matter how small, must keep a record of every transaction

Case Study
A small business owner’s day-to-day activities usually involve managing their
business and carrying out the role of a book-keeper. As a book-keeper, the owner’s
role would involve the following tasks.

Collecting Recording data Posting data

business
documents

Including invoices, The documents collected will be The data posted to the
credit notes, recorded in relevant books of books of prime entry will
cheques, receipts prime entry such as the sales then be posted to
etc journal, purchases journal and relevant ledger
cash book accounts

Accounting
What is accounting?
Accounting uses the records of the book-keepers to prepare the financial statements
of the business
Accountants provide information to owners and managers which is used to
monitor progress of the business
help with decision making about how to improve profit or reduce loss
Accounting is the function carried out by accountants

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 Accountants are primarily responsible for managing, updating, correcting, and
reporting the business' accounts
What is the difference between accounting and book- Your notes
keeping?
Accounting and book-keeping have distinct functions
They support businesses at different stages of the financial cycle
Book-keeping involves keeping records of the day-to-day financial data of the
business
Accounting involves using the information recorded by the book-keeper to provide
information at regular intervals

Case Study
Barbara runs a burger bar called Barbara's Burger Bar. She hires Jack as an accountant
for her business. Jack runs his own accounting firm, 4J Accounting, with three other
partners: James, Jasmin and Junaid.
Jack visits Barbara's place of business and explains to her the types of financial
transactions he would like her to record as well as the rules and procedures for
Barbara to follow in recording these transactions.
Barbara carries out all of the book-keeping of the business.
After Barbara completes the book-keeping, Jack takes the records and puts them to
use. He transforms the records Barbara has collected in a way that can be used for
decision making. He creates financial statements which can be used to see where the
business is spending its money, where it is making money, and the financial health of
the burger bar. Jack will also conduct tax preparations and tax planning.

Examiner Tips and Tricks

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The purpose of accounting and book-keeping will usually appear on Paper 1 as a
multiple-choice question. The options might all sound relevant but read the wording
carefully to identify the purpose of the role, not the advantages of accounting or Your notes
book-keeping.

Worked Example
Which statement is correct?

A Accounting is the process of entering details of transactions into the books of

prime entry

B Accounting involves providing financial information for decision making

C Book-keeping involves creating the financial statements

D Book-keeping is only carried out once a year

Answer
A is incorrect as book-keepers enter details of transactions into the books of
prime entry.
C is incorrect as accountants create the financial statements, although book-
keepers might provide the information.
D is incorrect as book-keeping is performed day-to-day.
The correct answer is B.

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 Profit or Loss & Financial Position
Your notes
Profit or Loss
How does a business measure profit or loss?
An accountant prepares an income statement for a business to show if the business is
making a profit or a loss
The profit or loss is the difference between the total income and the total expenses
A profit is made if the income is higher than the expenses
A loss is made if the income is lower than the expenses

Why is it important to measure profit or loss?

The information provided by financial statements shows the owner what has happened
to the business during a certain period of time
This is usually a year
It can be used to monitor the progress of the business
If a profit is made, the owner is making money on their investment
If a loss is made, the owner might have to make changes to the business

Assets, Liabilities & Capital

How does a business measure its financial position?
An accountant prepares a statement of financial position to show:
Assets
Liabilities
Capital

What are assets?

Assets are things owned by the business
Premises, inventory, motor vehicles, money in the bank, etc
Assets also include amounts that are owed to the business by other people or
businesses
Money owed to the business by credit customers
These are called trade receivables
Current assets are short-term assets that the business intends to liquidate within a
year

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 Trade receivables, inventory, money in the bank, etc
Non-current assets are long-term assets that the business intends to own for more
than a year and they are not easily liquated Your notes
Premises, motor vehicles, etc
What are liabilities?
Liabilities are the amounts that the business owes to other people or businesses
Bank loans, bank overdraft, etc
Money owed to credit suppliers by the business
These are called trade payables
Current liabilities are short-term liabilities which the business intends to pay within a
year
Trade payables, bank overdraft, etc
Non-current liabilities are long-term liabilities which the business intends to take
longer than a year to repay
Bank loans, etc

What is working capital?

Working capital is the amount of money a business would have left if it converted all of
its current assets into cash and paid off its current liabilities
Working capital = current assets - current liabilities
Working capital can be thought of as the capital available for its day-to-day trading
activities

What is capital or owner’s equity?

Capital is any resource provided by the owner to start up the business or keep it going
This is sometimes referred to as owner’s equity
Capital is often in the form of money
However, it may also consist of other assets
Such as buildings, furniture, equipment, motor vehicles, goods, etc
The owner invests capital into their business
Technically the business owes these assets to the owner
If a business makes a profit then its capital increases
If a business makes a loss then its capital decreases

What are drawings?

Drawings refer to when an owner takes assets from the business for personal use

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 This could be money, goods, motor vehicles, etc
If the owner takes drawings from the business then the capital decreases
Your notes

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 The Accounting Equation
Your notes
The Accounting Equation
What is the formula for the accounting equation?
The formula for the accounting equation is: Assets = Liabilities + Capital
The equation states that the assets of a business are always equal to the liabilities and
capital of the business
You can rearrange the equation so that you can find one of the three values if the other
two are known
Liabilities = Assets - Capital
Capital = Assets - Liabilities

The accounting equation

Examiner Tips and Tricks

You may be given examples of assets and liabilities and asked to calculate the missing
figure for capital.

Worked Example
The assets and liabilities are listed below for a business.

Premises 8 500

Equipment 7 000

Inventory 1 000

Trade receivables 5 000

Trade payables 4 500

Bank overdraft 1 200

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 Calculate the capital of the business.
Answer Your notes
Firstly, calculate the total assets:

Premises 8 500

Equipment 7 000

Inventory 1 000

Trade receivables 5 000

Total assets 21 500

Secondly, calculate the total liabilities:

Trade payables 4 500

Bank overdraft 1 200

Total liabilities 5 700

Finally, apply the formula Capital = Assets - Liabilities

$21 500 - $5 700 = $15 800

Why is the accounting equation important?

The accounting equation may be shown in the form of a statement of financial position
The statement of financial position will be affected every time the business makes
changes to the assets, liabilities and capital
Every single transaction will result in at least two changes which balance out
Both sides of the equation could increase by the same amount
Both sides of the equation could decrease by the same amount
Both sides of the equation could stay the same

Case Study
Hannah is the owner of a business. Some of her transactions are listed below. After
each transaction, the accounting equation still balances.

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Transaction Effects on assets Effects on liabilities
or capital
Your notes
A credit customer, Peter, pays the Assets increase by No change in
amount owed to Hannah by cheque $1 120 liabilities or capital
for $1 120
The money in the
bank increases
Assets decrease
by $1 120
The amount owed
by Peter decreases
Overall no change
to assets

Hannah pays the amount owed to a Assets decrease Liabilities decrease

credit supplier, Rizwan, by cheque for by $4 200 by $4 200
$4 200
The money in the The amount owed to
bank decreases Rizwan decreases

Hannah buys additional fixtures and Assets increase by Liabilities increase

fittings for $5 500 on credit from $5 500 by $5 500
FixFit Ltd
The value of The amount owed to
Hannah's assets FixFit Ltd increases
increases

Hannah takes goods worth $500 Assets decrease Capital decreases

from the business for personal use by $500 by $500
The amount of Hannah takes
inventory drawings from the
decreases business

Hannah transfers $1 000 from her Assets increase by Capital increases by

personal bank account into the $1 000 $1 000
business bank account
The money in the Hannah invests
bank increases $1 000 into the
business

Hannah makes $20 profit by selling Assets increase by Capital increases by

goods which cost $30 for $50 cash $50 $20
The amount of cash A profit has been
increases made
Assets decrease
by $30
The amount of
inventory

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 decreases
Overall assets Your notes
increase by $20

Worked Example
A business pays one of its trade payables by cheque. Identify the effects on the
business' assets and liabilities.

Effect on assets Effect on liabilities

A Reduce bank Reduce trade payables

B Increase bank Increase trade payables

C Reduce trade payables Reduce bank

D Increase trade payables Increase bank

Answer
Money in the bank is an asset and trade payables is a liability. A payment made by
cheque would reduce the money in the bank, therefore reducing the asset. Trade
payable is a liability. The business debt would be reduced when payment is made.
The answer is A.

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